Turkey lira falls after bank dashes rate expectations

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Ankara (AFP)

Turkey's central bank Thursday dashed expectations of a sharp rate hike to combat high inflation and currency weakness, prompting a drop in the value of the lira and fears of political meddling.

The market consensus had been for an increase of 100 basis points in the benchmark interest rate to combat inflation of almost 13 percent and the weakness of the lira, at a time of strong growth.

But the nominally independent central bank left the benchmark repo rate unchanged at 8.0 percent, it said in a statement after its latest monetary policy meeting.

The overnight borrowing rate was also kept unchanged at 7.25 percent, while the marginal funds rate held steady at 9.25 percent.

Only the late liquidity window lending rate was hiked, by 50 basis points to 12.75 percent. The central bank employs multiple interest rates -- which it often changes at different times -- in a complex monetary policy strategy.

The lira -- which has lost over 30 percent in value against the dollar over the last two years -- fell 1.55 percent in value to trade at 3.87 to the greenback, dropping sharply as the decision was announced.

The lira had strengthened against the dollar over the last week, as markets priced in what they thought would be a substantial rate hike.

"The central bank's rather shy move has left the currency exposed to further depreciation pressures," said Gokce Celik, chief economist at QNB Finansbank in Istanbul, in a note to clients.

- 'Reflects political pressure' -

The decision comes after Turkey posted growth of over 11 percent in the third quarter, data which analysts believed would give the bank room for a bigger rate hike.

But President Recep Tayyip Erdogan has made clear his opposition to rate hikes at the current time, telling the bank that rate cuts are needed to further stimulate growth.

The repo rate has stood at 8.0 percent since November 2016.

The president, whose popularity is based around giving Turkey prosperity after the chaos of the 2000-2001 financial crisis, will be seeking re-election in 2019 polls with the economy a key issue.

He has repeatedly stated his belief that high interest rates drive up inflation, flying in the face of economic orthodoxy.

Erdogan declared on Tuesday "it was not possible for inflation to fall in a country with high interest rates", describing justifying rate hikes as a "futile effort".

"The bank's decision to opt for a smaller hike... than markets anticipated seems to reflect political pressure not to tighten policy substantially," said William Jackson, emerging markets economist at Capital Economics in London, in a note to clients.

- 'Further tightening' -

In its statement, the central bank left the door open to an interest rate hike in the future, saying its "tight monetary policy stance" would be maintained until the inflation outlook shows a "significant" improvement.

Inflation hit its highest annual rate since 2003 last month at 12.98 percent, making a mockery of the central bank's 5.0-percent inflation target.

"Inflation expectations... will be closely monitored and, if needed, further monetary tightening will be delivered," the bank said.

Analysts have warned that the impressive growth data could mask trouble ahead for the Turkish economy, with its current account deficit widening and much of the increase in activity built on a credit boom.

"The economy's problems of high inflation, unanchored inflation expectations, rapid credit growth and a widening current account deficit, mean monetary conditions will need to be tight," said Jackson.

Celik of QNB Finansbank warned that further depreciation of the lira risked fuelling inflation further and thus could create the need for a much weightier hike by the bank next year.

"The bank's preference to under-deliver today and try to get away with a smaller rate hike might prove an expensive bet," said Celik.